China has in recent years begun to liberalize its markets. One effect has been the growth of still nascent futures and options exchanges. Today, China has five domestic derivatives exchanges and trading volumes have been on an upward trajectory as domestic investors become more familiar with futures and options, and demand from foreign investors increases.
With global uncertainty on the rise in the wake of the pandemic and most developed economies wading through a low rate environment, China’s growing access to risk management tools could play a much bigger role in the years ahead.
CME Group and Singapore Exchange (SGX) recently expanded their Mutual Offset System (MOS) to include the E-mini FTSE China H50 Index Futures and the E-mini FTSE Emerging Index futures contracts, which allows traders to open a futures position on one exchange and liquidate it on the other, creating a unified 24-hour marketplace across the exchanges.
OpenMarkets spoke with Michael Syn, senior managing director and head of equities, Singapore Exchange; Ricardo Manrique, director, derivatives strategy, FTSE Russell; and Christopher Fix, managing director, head of Asia, CME Group, to hear their thoughts on the growth of China’s derivatives markets, and how the various market constituents are stepping up to better serve evolving risk management needs in a new environment. Following is an edited version of our conversation.
OpenMarkets: What are your thoughts on the development of the Chinese derivatives markets? How has your organization been able to tap into China’s growth?
Michael Syn: China’s weightage and impact in global capital markets have grown substantially in the past two years. Global investment benchmarks make China's equity and currency risk premium one of the most important development priorities for international investors, especially in the current low-yield and fragmenting macro environment. Singapore’s market jurisdiction has uniquely deep and strong trade and capital links connecting China with the rest of the world: across bonds, equities, currencies, commodities, and freight.
SGX has been a first mover and early supporter of China’s internationalization. Across our multi-asset derivatives waterfront, we have worked closely with clients to offer high-impact tools to capture access opportunities for China’s growth and the ongoing growth of Chinese assets into global portfolios. We have seen strong growth in our China derivatives shelf: the hyper-liquid China A50 equity futures; the dominant USD/CNH (dollar/renminbi) futures and options; and the world-leading suite of iron and steel derivatives that serve as a China macro proxy for asset managers. Our role is to continue serving international customers with broadening access and liquidity while strengthening efficiency and trust in the marketplace.
Christopher Fix: A combination of increased global economic uncertainty and ongoing liberalization of its financial markets looks set to accelerate the development of China’s derivatives industry.
The heightened uncertainty caused by the COVID-19 pandemic has made corporates realize the importance of risk management and this has accelerated the corporate agenda, increasing domestic demand for both existing and new derivatives products. At the same time, rising levels of foreign investment in China have also created an increased need for using futures and options, further driving the development of the derivatives market.
Derivatives are still a relatively new product in China compared with Western markets. The first futures exchange was approved in China in 1990, and since then the number of different products available has been gradually expanding, with new products continuing to be launched. We have partnerships with a number of Chinese exchanges and institutions, and one of the most significant to date is that with Shanghai Gold Exchange, whom we cooperated with to launch Shanghai Gold Futures in 2019, connecting CME Group -- the world's most liquid precious metals derivatives market, and SGE -- the largest physical gold exchange.
Ricardo Manrique: The inclusion of China ‘A’ equities into the FTSE Global Equity Index Series (GEIS) began in June 2019 and followed a three-phase approach whereby today China ‘A’ shares represent over 6% of the free float weighted market capitalization of the flagship FTSE Emerging Index. On the fixed-income side, we recently announced that Chinese government bonds will join the FTSE Russell World government bond index, or WGBI, over a period of 36 months beginning from October 2021.
This inclusion of China equities and fixed income securities into international benchmarks such as FTSE EM and WGBI is driven by the needs of global investors and their investment decision-making process. In turn, we work with global derivatives exchange partners CME Group and SGX to ensure that the global investment community benefits from the development of the risk management ecosystem that partners such as CME Group and SGX are well placed to create. We expect these index risk management ecosystems to continue developing and evolving in line with the continued growth of the Chinese economy, capital markets, and investment allocations from international investors.
OpenMarkets: Risks do not simply stop at borders, and they change as time goes by. With the markets evolving over the years, how does the philosophy of risk management differ today compared to when you first joined the industry?
Michael Syn: Broadly speaking we have seen that Asia’s rapidly increasing weight in global markets means that shock transmission now happens in a more complex, bidirectional mode and in a 24-hour continuous context. For both compensated and uncompensated risks, the exchange’s role as an ecosystem risk manager now spans a wider remit, particularly in technological and cyber aspects. Exchange risk management is increasingly real-time in nature and management of customer portfolios is now increasingly about risk management as much as return management.
Christopher Fix: There is no doubt that the world has become a significantly more complex place since the Mutual Offset System (MOS) was first launched in 1984. It is often said that “change is the only constant.” The accelerated pace of change increased global connectivity, and heightened geopolitical tensions have all added new challenges to risk management. The COVID-19 pandemic has served to show just how interconnected the world now is.
All of these factors mean risk management needs to be more agile than 30 years ago and responsive to events outside of individual geographical boundaries. As a result, the need to be able to take action to manage new and emerging risks and hedge against them 24 hours a day has never been so important.
Ricardo Manrique: A key driver of risk management needs has clearly been the unprecedented growth in economic output, capital markets, and investible assets, which has led to the globalization of equity investing and therefore the institutional investors’ need to risk manage those global equity allocations. In the case of FTSE Russell, we now have over $2 trillion in assets benchmarked against the FTSE Global Equity Index Series (GEIS) alone and only recently surpassed $1 trillion in assets that are tied to FTSE Russell index-based ETF’s listed around the world.
This globalization of equity investing and the cross-border nature of investing and risk management is why we are so excited to partner with CME Group and SGX on facilitating global risk management access for EM and China index risk through the MOS.
OpenMarkets: What challenges does the current market uncertainty create for risk management? How can global investors better manage their risk using the various risk management tools provided by derivatives exchanges?
Michael Syn: Flight-to-quality in an environment of market uncertainty places a premium on trust and transparency, but it also offers an opportunity for exchanges to shine. By offering round-the-clock trading across different asset classes, we are enhancing access and collateral efficiency while improving the quality of price formation and liquidity formation. Global investors seek fewer, better exchange relationships and the Mutual Offset System between CME Group and SGX offers a great example of what is possible when two trusted global exchanges come together to provide market participants choice of clearing venue, along with the assurance of round-the-clock liquidity. We are proud to be standing together with CME Group at the forefront of serving investors with this innovation, which traces its roots to 1984 and remains relevant today.
Christopher Fix: For us at CME Group, we continue to explore partnerships and work with various market constituents to serve the increasingly sophisticated needs of our clients. We see ourselves partnering with SGX for example to bring the Mutual Offset System to our combined client base, and to collectively work on innovative, client-centric solutions that best meet end users’ needs. We do not see other exchanges as competitors, as we believe in creating win-win solutions for our clients, and this to me, is the biggest hurdle that the derivatives industry has to overcome, in order to continuously be ahead of the curve bringing to market the best-in-class solutions.
Ricardo Manrique: As an index provider, our primary purpose is to provide the lens into markets through indexes that allow global investors to measure market performance, benchmark, and undertake research. We rely on the expertise of our exchange partners CME Group and SGX to develop the risk management markets and tools that serve the needs of investors and allow them to manage risk and uncertainty. That said, we have clearly seen a trend in the continued growth of risk management needs. In the case of FTSE Russell alone, there were nearly 275 million FTSE Russell index-based futures & options contracts traded in 2020, a nearly 20% increase in volume on the previous year.
OpenMarkets: With new policy easing measures announced by Beijing, what opportunities does E-mini FTSE China H50 create for Chinese investors? How can Chinese onshore customers participate in light of these developments?
Michael Syn: As China pivots to a consumption-driven economic growth model and takes global leadership as a broad-spectrum technological powerhouse, SGX offers a well-developed product shelf that offers global investors access to both traditional and new economy sectors, in onshore (A-share) and offshore China equities. SGX’s FTSE China A50 Index Futures are now complemented by the highly regarded FTSE China H50 Index Futures and Options, available for seamless post-trade interoperability with CME Group through the MOS. All SGX’s China products are fully compliant with the superset of U.S. and global regulations. Clients seek continuity and stability in the face of sudden regulatory restrictions and our partnership with CME Group aims to provide that with the FTSE China H50 suite.
Christopher Fix: Beijing is said to be ready to further relax the restriction of onshore capital investing in offshore markets. For instance, the China Banking and Insurance Regulatory Commission recently announced plans for a pilot program allowing six insurers to offer private pensions. The pilot has two main impact points, particularly if it is later rolled out on a larger scale, namely broadening the investment options available to Chinese consumers and increasing the need for risk management strategies for the insurers investing their money.
As Chinese investors become increasingly sophisticated, they are likely to look for alternative investments, such as those offered by the E-mini FTSE China H50. The products offered via MOS allow Chinese investors to be able to manage their overnight risks just like any investors around the world. And I think the product would give them another option to hedge their investment risks. At the same time, they are also given greater access to the combined liquidity of both CME Group and SGX in a single marketplace.
Ricardo Manrique: Our partnership, as an index provider, with CME Group and SGX, is unique in that the MOS creates a global pool of liquidity on FTSE Russell index-based derivatives that is accessible around the global clock for all investors in all regions, international and domestic. As stated, this is an innovative program that is time-tested and will benefit the risk management needs of the entire global investment community.